Tax Issue Roundup 6/30/2024

Flyfin Tax Gives Suss Tax Advice.

Flyfin Tax is a tax-deduction app for freelancers that uses AI to help them spot deductions. Recently they posted on IG different “deductions” freelancers are entitled to:

The issue with this post is CONTEXT. These are actually deductions ANYONE, not just freelancers, are able to take medical deductions. The thing is, these deductions occur on your Schedule A - which are where individual tax filers put itemized deductions (medical, taxes, mortgage interest, charitable donations). But, unless your itemized deductions exceed the standard deduction ($13,850 filing single and $27,700 filing married), you won’t be able to utilize them.

Additionally, your medical deductions have to exceed 7.5% percent of your AGI before you’re allowed to take them. So if your AGI is $100k, your deductible medical expenses would begin once they exceed $7,500.

This is a good example of how NOT to give tax advice on social media - there are extra details that are needed in order to take the deduction correctly. Based on just the social media post, freelancers could very well believe they can take these medical costs as a business expense.

Another Hobby Loss Ruling.

When the tax law changed in 2018, one important change for individuals involved Hobby Loss deductions.

As a reminder, the IRS considers a “Hobby” as something you're not doing as a business, but still make income off of. There are nine different factors the IRS takes into consideration when determining if you’re running a business or a hobby.

With a hobby, income gets reported as “Other Income” (meaning it’s not subject to self-employment taxes) but any expenses are not deductible. Prior to 2018, they were deductible as a Sch. A Misc Itemized Deduction but only up to the amount of income made.

Now I love juicy tax court cases, especially ones involving luxury yachts, as much as the next person - and there was just a ruling released in the 11th Circuit for Gregory v. Commissioner involving hobby loss rules that occurred in 2014 and 2015 - so any losses were still potentially eligible for a deduction against income if reported as a Misc. Itemized Deduction - which similar to the medical expense deductions, are subject to a floor before the deduction can be taken, which in this instance was 2%

The first thing the Gregorys did wrong is they reported their yachting activity as a “for profit” business and put the income and expenses on their Schedule C. When audited, the IRS determined this was not a for-profit motive and moved the income to “Other Income and their expenses under Misc. Itemized Income.

Now the Gregorys earned $19M in 2014 and $80M in 2015, so the amount of eligible expenses they were able to take because of the 2% AGI threshold was only a couple hundred dollars. The Gregory’s tried to argue that those expenses were not subject to the 2% floor, and the tax courts were like, no they are, the language is pretty clear on this, and ended up assessing deficiencies of $267k.

Hobby Loss cases have been tried numerous times in the tax courts, so it’s surprising to me that the Gregory’s tried to fight this. And again, for 2018-2025, hobby expenses aren't deductible anywhere for tax purposes. It will be interesting to see if they let this particular part of the tax-law changes from 2018 sunset or if Congress will decide to renew it.

TikTok Trust Schemes.

Without fail, every week I will see some “guru” on TikTok parroting forms of Charitable Remainder Annuity Trusts (CRAT) as a way to “avoid” taxes. The idea is this - you take appreciated assets - you donate to a CRAT at your original basis (not the FMV of the appreciated assets), the trust sells the property, set up an annuity within the Trust, name yourself as the beneficiary (or other family members), and annual annuity payments as income, with a remainder portion of the assets in the trust going to a charity of your choosing. With this set-up, the trust doesn’t pay the income tax, the beneficiaries do as they receive it - so it can be a good tax-planning strategy because you stretch income over a period of years, and thus can pay lower effective tax rates.

Where these scammy trust sales-people get this wrong, is they allege that the annuity payment to you isn’t taxable based on their incorrect reading of the tax code and understanding of how trust-accounting works (basically they assert the distributions come from Corpus and thus aren’t taxable, when in reality it has to do with calculating Distributable Net Income, not the taxability of the payments).

A definitive ruling was just made in Gladys L. Gerhardt et al. v. Commissioner reaffirming the taxability of annuity payments to the beneficiaries (hat-tip to Ashley Francis).

The Gerhardts, along with some other taxpayers, all contributed assets (most over $1M) to their respective trusts (which were set-up by a law firm) and designed it with a 5-year annuity payment. During that time - none of them reported the bulk of the annuity payments as taxable to them, only a little bit of interest income.

Basically - the Gerhardts and their dummy attorney’s thought the gain from the sale of the asset, because it happened within the CRAT, would not be taxable. They thought by moving the property into the CRAT, it would receive a step-up in basis to the FMV or the property when it was transferred in, and then upon sale no gain would be recognized and thus their distribution would be tax-free. Dumb dumb dumb. My personal favorite quote from the ruling is “The gain disappearing act the Gerhardts attribute to the CRATs is worthy of a Penn and Teller magic show. But it finds no support in the Code, regulations, or caselaw.”

I’ve said it once and I’ve said it again - if something seems too good to be true, it probably is.

Charitable LLCs.

This is the first I’ve come across talk about Charitable LLCs (hat-tip to Cordasco & Co CPA’s ) so I’m imagining it will probably be the first of many I see (which means us tax professionals need to put out content to nip it in the bud).

The scheme with this one involves putting your paycheck into a Charitable LLC, and somehow doing so reduces your taxable income by 80%, and thus your taxes by 50%. What? Justin Miller thankfully has an article out about Charitable LLCs which addresses these schemes.

The first thing to keep in mind about these entities is that unlike a non-profit entity, these are not tax-exempt; it’s a pass-through entity, so the taxes will pass-through to the owners of the LLC. And contributing money to it, is not a tax deduction because it’s considered a for-profit entity.

Where tax deductions can be unlocked is if they donate to a charity ownership in the LLC. You are now getting a deduction for that percent you contributed.

Here is where the potential fraud now comes in. Let’s say you gifted 90% of the LLC to a charity - there are no rules that cash actually has to be distributed. To keep it very simple, let’s say you donated $1M, so you get a $900k charitable deduction, but there is still $1M sitting in the Charitable LLC bank account. Then you take out a loan on that money (at whatever interest rate that’s determined) and you’re able to spend that money as you please.

In that article Justin says some people will take it once step further, and offer for a trust of theirs to buy-back the interest from the charity at a reduced amount, let’s say $400k in this scenario (which the charity will happily accept because it’s cash) - so they end up getting a huge charitable deduction ($900k) without having to pay the charity that amount.

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